A day that shall live in infamy

First, the notion that the Federal Government has made the world safe again by offering to absorb all the toxic debt out there in an RTC-style entity is absurd. (Note: Resolution Trust Corp = the government entity that ate all the bad S&L debt back in the 1980's). Assuming this idea even gets off the ground, all that will have happened is that private debts than have gone sour will have been transferred to the public.

Will the debts be reduced? No, just transferred.

But a number of $500 billion has been bandied about as "the right size" to get the job done.

My friend Gunter has a different view (he works for a major financial institution overseas):

Quote:

Hello Chris,

I have not seen a number yet but here is my quick and dirty calculation

For this calculation I assume that financial institutions are leveraged by a
factor of 10. In reality I think the multiple may be even
higher.

If we assume that equity capital markets for financial institutions
remain closed the existing capital shortfall of USD 153.9bln requires the sale
of (mostly troubled) assets in the amount of......................USD 1.539 trillion

Assuming that an estimated amount of USD 1.300 bln in total credit losses and
write downs will hold (risk is on the upside in my view) there are at least
another USD 783.30 bln (1.300 minus 516.7) to be realized which will result
in another........................USD 7.833 trillion
and in total
USD 9.372 trillion

So no obvious sense of spending restraint showing up in DC yet. I guess the mood down there is that we can have a $600 billion + military budget and a $500 billion bailout and everybody will be fine with that. No sense of priorities, sacrifice, or tradeoffs yet. It's still a version of "Yes, I'll have one of everything" at the old taxpayer buffet table.

And:

Quote:

The Federal Reserve Board on Friday announced two enhancements to its programs to provide liquidity to markets. One initiative will extend non-recourse loans at the primary credit rate to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds. This should assist money funds that hold such paper in meeting demands for redemptions by investors and foster liquidity in the ABCP markets and broader money markets.

To further support market functioning, the Federal Reserve also plans to purchase from primary dealers federal agency discount notes, which are short-term debt obligations issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.

The SEC extending the ban on short selling to 799 companies. This is going to backfire on the SEC, big time. Short selling has been used for many decades and is an embedded part of many trading strategies. Removing short sales will certainly do two things; (1) provide a 'pop,' as short sellers cover their positions and less selling pressure comes into the market, and (2) assure that the next bottom will be far lower, deeper, and longer than past bottoms. Short covering is the #1 reason that bottoms are found. Remove that, and the bottoms are less crisp, more like a boggy pond than a concrete pool.

And:

Quote:

Sept. 19 (Bloomberg) -- The U.S. government will set aside as much as $50 billion to temporarily protect investors from losses in money-market mutual funds caused by the meltdown of financial markets.

...I could go on and on. The main point is this: Rules are being broken and changed so fast that I cannot possibly analyze them all fast enough.

And the bottom line is this: The US has just announced close to three quarters of a trillion dollars of new spending/borrowing, while the Federal Reserve is now accepting everything from auto loans to commercial paper, to equities, to Fannie debt.

The dollar *should* be getting killed here. It is not, yet, but markets have a way of settling themselves out, and I have little doubt about the long-term direction of the dollar, given everything that has happened this week. In my assessment, this entire stock-market propping of the last 24 hours is a fake rally designed to buy some time.

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26 Comments

i am not political but i really think mccain is missing a grand opportunity here.
i think he should leave the republican party and restart the bullmoose party.(he does have a running mate who can field dress a moose) he would leave all the toxic trash of the bush administration. he could then reinstate glass -steagall(which his #1 economic advisor did away with in 99) after all he is now in favor of more regulation. he could then put the new veep in camo at the head of our new invasion of dubai. because it really wont be about oil. we will be just going in to get our money back. talk about shock and awe.
we will then be in possession of the worlds largest indoor ski slope. which will be great for paulson and bernanke because they will need new jobs soon. they can sell lift tickets and remind people that the ride up takes a lot longer
than the slide down. and that they should be careful because it is a very slippery slope. sound absurd? anyone reading the paper?

Hi. Great website. But a question. You keep saying you're stunned by the actions of the Fed and Treasury, but you don't say how you would manage things differently. Forget for a moment about how we got here. The situation is what it is. What would you do as Fed chief, or Treasury sec, or even President? Surely you would not go on TV and tell everyone to make a run on the banks and buy gold. Seriously, how would you manage it? Wouldn't you, too, break some rules? Thanks.

Chris fantastic site, love it.
The US govt. is buying time and this should be seen as a VERY BAD sign.
As you say, this is a totally unrealistic plan, and the stock market rally is hysterical (in both senses of the word)
Check out this link to the BBC Business Correspondent (I am a Brit)
http://www.bbc.co.uk/blogs/thereporters/robertpeston/
If an unfunded, "back of a cigarette packet" plan can cause the markets to react so violently than all rationality has been bled from the process.
Why buy time with a hopelessly unrealistic and unaffordable plan: because the future is going to be very black indeed
I think we could be looking at Meltdown Monday as the day the money markets freeze.
Keep up the good work

...it like this. My goal would be to get the rot out of the system as rapidly as possible and not prolong the misery. A bottom exists and getting there rapidly assures we can begin rebuilding sooner. At no point would I risk the US dollar's reserve currency role.

I'd let AIG go under in search of a rapid bottom rather than a long prolonged affair.

Beware the predators. I would be cognizant of the fact that any money dumped into the market is far more likely to be immediately ripped out of the market by the predator class of black-box market participants that exist than it would to end up in a helpful spot.

Begin a return to accountability. I'd make a very public example out of a whole host of CEOs and other executives. Forget Martha Stewart, Mr Fuld needs to go to prison. So does Mr, Raines, the entire CFC executive staff and about 100 other guys I could mention.

Instead of pouring money into financial firms, which is already destroyed so where's the gain(?), I would immediately announce a large program of government spending on energy and transportation infrastructure with slightly above market pay rates (to begin the long process of raising salaries up towards the collapsing house prices). I mean, if the government is going to spend the money anyway, why not get something for it? Trust me, we get absolutely nothing out of the Wall Street bailout. Nothing. Those who would trade future prosperity for temporary market relief deserve neither.

I'd protect the dollar at all costs. Most are unaware of the exorbitant privilege that's been afforded by reserve currency status. Risking a sudden unwinding of 30 years of excess spending risks the entire social and economic fabric of this country. That's precisely what this sudden flurry of lavish bailouts places at risk. Instead of annoucning untold hundreds of billions of dollars of bailouts AND full maintenance of all other spending programs is simply reckless fiscal polciy of the highest order. Sure, it's an emergency but later, when it's not, politicians will simply try to forget about it all and move on to new additional deficit spending. It has to stop at some point and if not now, then when? My concern is that these programs all indicate that the mindset is "we're not going to stop until we crash this thing".

It's not that I love gold, it's that I hate how my paper money is being managed. There is nothing inherently wrong with a fiat currency as it is possible for them to be managed properly. Ours is being mismanaged to a staggering degree and its odds of failure are high.

My entire stance on gold is to simply preserve my wealth, not to 'get rich'.

And before anybody says "yes but you can't eat gold" I'd just like to say that I tried eating a $10 bill and it tasted just as bad and was just as unfilling as the $5 bill I ate earlier.

Does anybody know what GW thinks about the whole affair!!!
I'm sure he could give us a laugh or two as there does'nt seem to be anything left in the kitty to laugh over. Great website once again Chris.

"I'd protect the dollar at all costs. Most are unaware of the exorbitant privilege that's been afforded by reserve currency status. Risking a sudden unwinding of 30 years of excess spending risks the entire social and economic fabric of this country."
Presumably the rest of the world pays for this "exorbitant privilege"? And you'd prefer that they continue doing so?

I was specifically asked "if I was the government or Fed" what would I do?

If the question was "what would you do if you were suddenly made the autocratic ruler?" I would have a different set of answers.

But the more important question for the rest of the world is "why do you continue to allow the US to abuse its privilege?". Make no mistake, the dollar should be swirling the bowl right now but it is not for reasons that I must conclude are based on the actions of foreign central banks.

I truly think it would be better for all concerned if this support was weaned off as rapidly as possible. This will mean the end of Bretton Woods II, but that was a mathematical certainty anyways so we might as well begin as soon as we can determining the replacement system(s).

The enabling of the dolalr by the BoJ and the ECB is only masking the signals we need to begin this period of readjustment and, while I appreciate the effort, it is only going to make things worse down the road.

Hey Chris,
My first time to comment. Great work. Thank you.
Isn't the real cause of all of this mess the fact that about 30 years ago our national leaders bought into the economic theories of one Milton Friedman (U. of Chicago) often called "trickle down economics", which says: (1) privatize government functions and assets, (2) set policies and practices that shift wealth upward to the powerful elite corporations and away from working folks,
(3) de-regulate business and operate as a so called "free-market" economy, and (4) take advantage of "disasters" to frighten folks, and if none occurs, then create them.
These were tried in upward of dozen other countries before us, and resulted in disaster for all of them. They came in under Reagan, and continued through all administrations, reaching its apex with the present administration.
I'm wondering if anyone will ever acknowledge this, and explain to the general voting population how it has worked, rather than just pointing fingers at each other.
Ben
P.S. I don't ignore the fact that many Americans spent their private funds recklessly and acquired too much debt, as well as the severe cost of ill-conceived war.

"I was specifically asked "if I was the government or Fed" what would I do?" Point taken.
"But the more important question for the rest of the world is "why do you continue to allow the US to abuse its privilege?"." Why indeed. Presumably, because having done so for so long, it will be very difficult (and for the major creditor nations, extremely costly) to stop. From my reading of your articles (and those of other commentators) I suspect that 'events' will eventually force everyone's hand.
Thank you for taking the trouble to reply to my post.

Check this out on Bloomberg...Paulson's big announcement to fix this mess. What's the acronym for Troubled Asset Relief Program...TARP. What do you use a tarp for? Hmmmm to cover things up.
http://www.bloomberg.com/apps/news?pid=20601087&sid=akDKPN1hzMZg&refer=home

Today in his speech he said that those responsible for fraudlent activity will be persecuted. I believe he meant Prosecuted. But perhaps we will just harass them and call them names. Maybe drag them by their feet down Wall Street or stone them in the city square. Better yet, have them battle Lions in Yankee Stadium - that'd be a good send off for the House That Ruth Built. Persecute...what a reknob.

Hi Chris,
When I saw your answer to "what you would do", it made me think of the response given by President Andrew Jackson in the 1830's, to comments from the US Central Bank President at the time, as to how Jackson could "put suffering on the people" by not allowing the Central Bank to get a charter to continue operation.
Here was his answer:
Andrew Jackson - "Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families more, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, I will rout you out."
(If you're aware of the history behind Andrew Jackson and the USA's earlier struggles with Central Banking, you'll know how passionate he was against it, as were the Founding Fathers in Jefferson, Madison and Adams. At one point, an assasination attempt was made on Jackson, of dubious origin, but he survived as the guns misfired. Upon his tombsone is engraved "I Beat the Bank!")
As to the question you were asked, issuance of the currency should be returned to the Treasury, in the form of tangible-backed US Notes (not Fed Res Notes), as per the US Constitution, correcting the unconstitutionality of the FED.
The savings in interest alone would pay for tremendous investments in the shared US infrastructure, which is a legitimate use of taxpayer money.
A direct transfer of 1-to-1 US Notes to Fed Res Notes should take place immediately, with the monies otherwise placed into the Resolution Trust redirected toward common infrastructure investment, insofar as no fractional-multiplier would take it.
The fractional multiplier effect should be born by the Banks only.

With banks dropping like flies and the stock market looking like the latest roller coaster, what should my friend do with over $100k that is tied up in mutual funds: let it ride, deposit in savings acct., buy gold, or put it in a sock drawer? My friend is over 60 years old and hopes to retire soon. I want to make sure that she money to do it! :)
Thanks!

Nice job on the latest installment of Crash Course Chris!
And I agree that this is a day for the history books. Truly unbelievable. Do you have any insights/opinions as to how events play out over the next several months?
It would appear that so far every financial levy that has been erected since last August has been overwhelmed by the toxic debt / derivative flood and now the Fed and Treasury have went "all in" with this latest bailout/reinflation scheme.
If this does not restore normalcy to the credit markets what else do they have left? And even if it does sooth debt markets will it fly in the currency markets?
Any thoughts?
Thanks

The idea that we're going to sequester all of the bad debt in a shadow organization and bail out the guilty parties is just ludicrous. We have somewhere between $600T and $1Q worth of derivatives globally, most of it leveraged, most of it gone bad just like spoilt milk. That's up to 1,000 Trillion dollars worth of sour paper. Even if we bailed out just 5% of it, it would be $50 Trillion. That compares to a world GDP of $66T?

I'd say we've got a lot of printing to do, and this is just a stall tactic.

Oh, and fabulous job on your Crash Course. I have never seen the peak oil net energy concepts presented so concisely. Thank you!

this is just an uneducated guess but i think they are bailing everyone out because they dont want to have all of this exposed in a bankruptcy court. assets on the books may really turn out to be liabilities or worth only pennies on the dollar not what they are declaring. if they sweep it under the govt rug we will never know the extent of the shenanigans.
but i could be wrong.
but my faith in the system was restored when i remembered alan saying "we at the fed have the most powerful econometric tools on the planet and just because we have been wrong the last 14 quarters doesn't mean we won't be right in the 15th"

Hello Chris and everyone else.
I've been keeping up with all of this news on your site and around the web. Needless to say, its terrifying and exhilarating at the same time.
My question/comment has to do with the North American Union which is supposedly to be announced by 2010. Because the North American Union will be a collaboration between the U.S., Canada and Mexico, do you believe that the fed is spraying money everywhere because it realizes that once the union is announced, the dollar will be replaced by the Amero and our problems will be solved because we can easily spread our problems towards Oil rich Canada and Mexico?
To me, there is no other logical reason why this is happening.

I do admit to being shocked when these events happen, but as a long student of Austrian Theory and economic history, the dons are following the same script as every other nation that resorted to inflation. They are going to destroy the dollar.
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
— Ludwig von Mises -- Get your gold and silver and beat the rush.